How to Pay Yourself From My LLC: Methods and Tax Rules

Limited Liability Companies (LLCs) offer business owners flexibility in structure and taxation, but compensating oneself from an LLC differs from receiving a traditional employee paycheck. Unlike employees who receive W-2 wages, LLC owners must understand how income is drawn, which is tied to the entity’s tax classification.

Understanding LLC Tax Classifications

The Internal Revenue Service (IRS) classifies an LLC based on its number of owners and any elections made. This classification dictates how the LLC’s income and expenses are reported. By default, a single-member LLC is treated as a “disregarded entity,” taxed as a sole proprietorship. Its financial activities are reported directly on the owner’s personal tax return, typically on Schedule C.

A multi-member LLC is typically taxed as a partnership. Both sole proprietorship and partnership classifications are considered “pass-through” taxation, where business profits and losses flow through to the owners’ individual tax returns, avoiding corporate-level taxation.

An LLC can elect to be taxed as a corporation by filing Form 8832, becoming a C-Corporation and subjecting its income to corporate tax rates. Alternatively, an LLC can elect to be taxed as an S-Corporation by filing Form 2553. S-Corporation status also offers pass-through taxation, but with specific rules for owner compensation.

Methods for Owner Compensation

The method an LLC owner uses to receive compensation is tied to the LLC’s tax classification. For single-member LLCs taxed as sole proprietorships and multi-member LLCs taxed as partnerships, owners take “owner’s draws” or “distributions.” These involve transferring funds from the business bank account to a personal bank account, representing a withdrawal of the owner’s equity.

In a multi-member LLC taxed as a partnership, owners may also receive “guaranteed payments.” These are payments made to a partner for services rendered or capital provided. Guaranteed payments are outlined in the LLC’s operating agreement.

When an LLC elects to be taxed as an S-Corporation or a C-Corporation, the owner receives a “reasonable salary” as W-2 wages. For S-Corporations, the IRS requires owners who actively work in the business to pay themselves a market-rate salary. This salary is subject to payroll taxes. Any remaining profits can then be taken as shareholder distributions, which are not subject to self-employment taxes. C-Corporation owners also receive W-2 salaries, and any additional distributions are typically paid as dividends.

Owners can also be reimbursed for legitimate business expenses paid on behalf of the LLC. Proper documentation, such as receipts and expense reports, is necessary to substantiate these reimbursements.

Tax Implications of Owner Compensation

The tax consequences of owner compensation vary based on the LLC’s tax classification and payment method. For single-member LLCs taxed as sole proprietorships and multi-member LLCs taxed as partnerships, owner’s draws and guaranteed payments are subject to self-employment tax. This totals 15.3% on net earnings from self-employment up to an annual limit, and 2.9% for Medicare on all net earnings. Owners pay both the employee and employer portions of these taxes.

For LLCs taxed as S-Corporations, the “reasonable salary” paid to owner-employees is subject to federal income tax withholding, Social Security, and Medicare taxes (FICA). Both the employer and employee portions of FICA taxes are paid on this salary. Distributions received from an S-Corporation are not subject to self-employment tax.

C-Corporations face a different tax structure, known as “double taxation.” The corporation pays income tax on its profits at the corporate level. When these after-tax profits are distributed to owners as dividends, the owners then pay personal income tax on those dividends. The W-2 salary paid to C-Corporation owners is subject to income tax withholding and payroll taxes, similar to other employees.

Reimbursements for business expenses paid by the owner reduce the LLC’s taxable income. These reimbursements are not considered taxable income to the owner.

Record Keeping for Owner Payments

Maintaining accurate records for all owner payments is important for LLCs, regardless of their tax classification. A fundamental practice is to separate personal and business finances by using distinct bank accounts and credit cards for the LLC. This separation provides a clear audit trail and simplifies financial tracking.

Detailed ledgers and accounting software document every payment made to owners, including the date, amount, and purpose. For W-2 salaries, payroll records show gross wages, withholdings, and net pay. For draws or distributions, a log detailing each withdrawal helps track the owner’s equity.

The LLC’s operating agreement often outlines the rules for owner compensation, including how and when distributions can be made. Adhering to these internal guidelines is important for internal governance and can support the legitimacy of payments during an audit.

These records feed directly into the LLC’s annual tax reporting. Accurate record-keeping ensures that the necessary forms are completed correctly and filed on time.

Single-member LLCs report income and expenses on Schedule C.
Multi-member LLCs taxed as partnerships file Form 1065 and provide Schedule K-1s to members.
LLCs taxed as S-Corporations file Form 1120-S and also issue Schedule K-1s.
LLCs taxed as C-Corporations file Form 1120.